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    Operations Strategy: Session 4

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    Venkatesh Nenavath
    The document discusses capacity strategy and capacity management. It addresses key topics such as what capacity is, different forms of capacity, capacity investments and the costs associated with them. It also summarizes different capacity timing strategies such as leading, lagging and smoothing strategies. The document discusses challenges in capacity strategy and how to determine the optimal timing of capacity investments by considering factors like economies of scale, demand uncertainty and using real options valuation approaches.

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    Operations Strategy: Session 4

    Uploaded by

    Venkatesh Nenavath
    54 views13 pages
    The document discusses capacity strategy and capacity management. It addresses key topics such as what capacity is, different forms of capacity, capacity investments and the costs associated with them. It also summarizes different capacity timing strategies such as leading, lagging and smoothing strategies. The document discusses challenges in capacity strategy and how to determine the optimal timing of capacity investments by considering factors like economies of scale, demand uncertainty and using real options valuation approaches.

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    The document discusses capacity strategy and capacity management. It addresses key topics such as what capacity is, different forms of capacity, capacity investments and the costs associated with them. It also summarizes different capacity timing strategies such as leading, lagging and smoothing strategies. The document discusses challenges in capacity strategy and how to determine the optimal timing of capacity investments by considering factors like economies of scale, demand uncertainty and using real options valuation approaches.

    Copyright:

    Attribution Non-Commercial (BY-NC)
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    54 views13 pages

    Operations Strategy: Session 4

    Uploaded by

    Venkatesh Nenavath
    The document discusses capacity strategy and capacity management. It addresses key topics such as what capacity is, different forms of capacity, capacity investments and the costs associated with them. It also summarizes different capacity timing strategies such as leading, lagging and smoothing strategies. The document discusses challenges in capacity strategy and how to determine the optimal timing of capacity investments by considering factors like economies of scale, demand uncertainty and using real options valuation approaches.

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    of 13

    Operations Strategy

    Session 4
    Dr. Partha P. Datta Operations Management Group E-mail: [email protected]

    A Light Beginning to a Serious Issue

    What is capacity & capacity strategy?

    Capacity Strategy involves long term plan for developing resources and involves decisions on sizing, timing, type and location of real assets or resources Capacity is the maximal sustainable output rate of a resource Capacity comes in many forms (Burger King, Google, Amazon, Flextronics) Utilization is the rate at which we choose to operate a resource at any given time
    3

    Capacity Investments
    Capacity is seldom FREE! One time investment cost Operating cost Additional costs Investment decisions:
    Partially or completely irreversible Uncertainty over future rewards (Virgins $5.5bn order of 13 Airbus planes in 2004 was nothing but a pure GAMBLE)

    The Key decisions & trade-offs


    Size
    Tradeoff between cost and service level

    Timing
    Cost of adjustment and expected cost of excess/shortage capacity

    Types/Locations
    Different capacity and total output

    Capacity Strategy Challenges


    A soft malleable constraint Black Art Capacity frictions: leadtimes, lumpiness & fixed costs Large and irreversible investments Capacity decisions can be political Measuring and valuing capacity shortages is not obvious
    6

    Capacity Timing Strategies Leading, Chasing, and Lagging Timing Strategies


    Volume (units/wk)

    Leading capacity strategy

    Lagging capacity strategy

    Decisions to make: Time = when? (lead or lag) Size = by how much? (many small, one big)

    Demand

    time

    Advantages of Leading

    Advantages of Lagging

    Volume (units/wk)

    Capacity Timing Strategies Hybrid timing strategy between lead and lag: Inventory-smoothing Smoothing
    capacity strategy Demand

    fills

    Inventory buildup

    capacity shortage

    time

    Two types of smoothing: inventory or backorders Advantages/disadvantages of smoothing strategies:

    Lead, Lag or Balance Model of Capacity Timing: How to choose?

    9 DELL, XBOX, Vodafone, Apple, Rolex, Zara, HP, Agilent Tech

    Economies of Scale (EoS) in Capacity Investment Two Capacity Investment Cost Models
    1. 2. Linear CapEx function: C(K) = c0 + cKK Power CapEx function: C(K) = c0 + (cK/a)Ka with 0 < a < 1
    Linear CapEx

    Capacity Cost C(K) or CapEx

    a=1
    a = .6 decreasing a

    slope = cK

    Power CapEx

    fixed cost c0

    $0 0

    Capacity Size K
    10

    Sizing Capacity Increments when Demand is Known or Certain: Guidelines


    As discount rates rise, add capacity in smaller increments Future expenditures on capacity are relatively less expensive Thus, delaying expenditures is more economical As scale factors (alpha) rise, add capacity in smaller increments Cost per increment of capacity goes down Making larger investments in capacity up front isnt worth it

    11

    The Value of Waiting


    Demand Scenario 1 Demand Scenario 2

    Demand Scenario 3

    Demand Scenario 4

    Existing capacity

    Year 0

    Time

    12

    Real Option Valuation: Acer Example


    Should Acer expand now, or should it wait an additional year before expanding into the emerging markets?
    The key reason for waiting is the belief that commercial success in emerging markets is highly correlated with success in the current Asian market. (Acer already has capacity in place to serve the Asian market. Aside from providing information regarding its future success, however, that capacity has no direct impact on our problem here.)

    Demand from these emerging markets is highly uncertain; marketing and sales reports predict that Acer's low-price PC will either be a blockbuster, a success, or a dud. Assume that the demand forecast for those three scenarios is, respectively: 200 thousand units per year with likelihood of 25%, 100 thousand units per year with 50% likelihood, or 30 thousand units per year with 25% likelihood. The cost structure is assumed to be as follows. Capacity expansion incurs a fixed cost of $8 million plus a marginal cost of $50 per unit of capacity; i.e., adding production capacity of 100,000 units per year costs $13 million. The process and product technology is commercially viable for four years (at that point a new technology would be needed, an issue we will ignore for now). Acer expects each PC to contribute about $80 in operating profits. A 25% discount rate is used for these types of investment projects.
    13

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